Edgar Filing: SOUTHCREST FINANCIAL GROUP INC

form10q.htm

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

___________________

FORM 10-Q

___________________

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 000-51287

___________________

SouthCrest Financial Group, Inc.

(Exact name of small business issuer as specified in its charter)

___________________

Georgia	58-2256460
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

600 North Glynn Street

Fayetteville, GA 30214

(Address of principal executive offices)

(770)-461-2781

(Issuer’s telephone number)

_____________________________________________________________________

(Former name, former address and former fiscal year, if changed since last report)

___________________

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer ¨

Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No S

State the number of shares outstanding of each of the issuer’s classes of common equity, as of November 14, 2008: 3,931,528.

SouthCrest Financial Group, Inc.

And Subsidiaries

INDEX

			Page
Part I.	FINANCIAL INFORMATION

	Item 1.	Condensed Consolidated Financial Statements

		Condensed Consolidated Balance Sheets – September 30, 2008 and December 31, 2007	1
		Condensed Consolidated Statements of Income - Three and Nine Months Ended September 30, 2008 and 2007	2
		Condensed Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2008 and 2007	3
		Condensed Consolidated Statements of Stockholders' Equity – Nine Months Ended September 30, 2008	4
		Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2008 and 2007	5
		Notes to Condensed Consolidated Financial Statements	7

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24

	Item 4.	Controls and Procedures	24

Part II.	OTHER INFORMATION		24

	Item 1.	Legal Proceedings	24
	Item 1A.	Risk Factors	24
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
	Item 3.	Defaults Upon Senior Securities	25
	Item 4.	Submission of Matters to a Vote of Security Holders	25
	Item 5.	Other Information	25
	Item 6.	Exhibits	26

		Signatures	26

Index

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SouthCrest Financial Group, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

September 30, 2008 and December 31, 2007

(Unaudited)

(In thousands, except share and per share data)

	September 30,			December 31,
Assets	2008			2007*
Cash and due from banks	$	14,602		$	16,060
Federal funds sold		84			9,316
Interest-bearing deposits at other financial institutions		16,861			10,637
Securities available for sale		83,397			79,208
Securities held to maturity (fair value $42,223 and $58,632)		42,468			58,885
Restricted equity securities, at cost		2,414			2,008
Loans held for sale		270			229
Loans, net of unearned income		398,459			373,825
Less allowance for loan losses		6,189			4,952
Loans, net		392,270			368,873
Bank-owned life insurance		16,821			16,302
Premises and equipment, net		19,303			18,093
Goodwill		14,255			14,255
Intangible assets, net		4,096			4,792
Other assets		13,694			7,351
Total assets	$	620,535		$	606,009

Liabilities, Redeemable Common Stock, and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing	$	76,024		$	80,685
Interest-bearing		438,973			433,246
Total deposits		514,997			513,931
Short-term borrowed funds		15,582			3,055
Long-term borrowed funds		6,555			6,555
Other liabilities		10,466			9,656
Total liabilities		547,600			533,197

Commitments and contingencies

Redeemable common stock held by ESOP		1,061			1,091

Stockholders' equity:
Common stock, par value $1; 10,000,000 shares authorized, 3,931,528 issued		3,932			3,932
Additional paid-in capital		49,785			49,707
Retained earnings		18,374			17,881
Unearned compensation - ESOP		(326	)		(349	)
Accumulated other comprehensive income		109			550
Total stockholders' equity		71,874			71,721
Total liabilities, redeemable common stock, and stockholders' equity	$	620,535		$	606,009

See Notes to Condensed Consolidated Financial Statements.

* Derived from audited consolidated financial statements.

Index

SouthCrest Financial Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

For The Three and Nine Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands, except share and per share data)

	Three Months					Nine Months
	2008			2007		2008			2007
Interest income:
Loans	$	6,915		$	7,840	$	21,088		$	21,654
Securities - taxable		1,339			1,548		4,081			4,190
Securities - nontaxable		230			241		688			594
Federal funds sold		20			94		236			351
Interest-bearing deposits at other banks		155			92		405			265
Total interest income		8,659			9,815		26,498			27,054

Interest expense:
Deposits		3,028			3,682		9,860			9,900
Other borrowings		122			229		330			415
Total interest expense		3,150			3,911		10,190			10,315

Net interest income		5,509			5,904		16,308			16,739
Provision for loan losses		837			212		2,307			438
Net interest income after provision for loan losses		4,672			5,692		14,001			16,301

Other income:
Service charges on deposit accounts		1,025			1,036		2,987			2,771
Other service charges and fees		397			340		1,148			957
Net gain on sale of loans		31			112		251			350
Impairment charge on investment securities		(570	)		-		(570	)		-
Net gain on sale and call of securities		-			-		119			-
Income on bank-owned life insurance		170			168		519			428
Other operating income		117			132		478			386
Total other income		1,170			1,788		4,932			4,892

Other expenses:
Salaries and employee benefits		2,940			2,841		8,683			7,794
Equipment and occupancy expenses		655			552		1,864			1,508
Amortization of intangibles		276			276		817			774
Other operating expenses		1,517			1,451		4,418			4,089
Total other expenses		5,388			5,120		15,782			14,165

Income before income taxes		454			2,360		3,151			7,028
Income tax (benefit) expense		(22	)		710		663			2,174
Net income	$	476		$	1,650	$	2,488		$	4,854

Basic and diluted earnings per share	$	0.12		$	0.42	$	0.64		$	1.23
Dividends per share	$	0.13		$	0.13	$	0.39		$	0.39
Average shares outstanding - basic and diluted		3,916,707			3,952,328		3,916,239			3,952,328

See Notes to Condensed Consolidated Financial Statements.

Index

SouthCrest Financial Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

For The Three and Nine Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands)

	Three Months					Nine Months
	2008			2007		2008			2007

Net income	$	476		$	1,650	$	2,488		$	4,854

Other comprehensive income:
Unrealized holding gains (losses) on securities available for sale arising during the period, net of taxes of $405, $335, ($98), and $267		665			543		(161	)		453
Impairment charge on investment securities, net of taxes of ($216), $-0-, ($216), and $-0-		(354	)		-		(354	)		-
Reclassification adjustment for gains included in net income, net of tax of $-0-, $-0-, $45 and $-0-		-			-		74			-

Comprehensive income	$	787		$	2,193	$	2,047		$	5,307

See Notes to Condensed Consolidated Financial Statements.

Index

SouthCrest Financial Group, Inc.

And Subsidiaries

Consolidated Statement of Stockholders' Equity

For The Nine Months Ended September 30, 2008

(Unaudited)

(In thousands, except share and per share data)

	Common Stock				Additional Paid-In		Retained			Accumulated Other Comprehensive			Unearned Compensation			Total Stockholders'
	Shares		Par		Capital		Earnings			Income			(ESOP)			Equity

Balance, December 31, 2007		3,931,528	$	3,932	$	49,707	$	17,881		$	550		$	(349	)	$	71,721
Net income		-		-		-		2,488			-			-			2,488
Adjustment resulting from adoption of EITF Issue 06-4		-		-		-		(493	)		-			-			(493	)
Cash dividends declared, $.39 per share		-		-		-		(1,532	)		-			-			(1,532	)
Stock-based compensation		-		-		78		-			-			-			78
Adjustment for shares owned by ESOP		-		-		-		30			-			-			30
Principal reduction of ESOP Debt		-		-		-		-			-			23			23
Other comprehensive loss		-		-		-		-			(441	)		-			(441	)
Balance, September 30, 2008		3,931,528	$	3,932	$	49,785	$	18,374		$	109		$	(326	)	$	71,874

See Notes to Condensed Consolidated Financial Statements.

Index

SouthCrest Financial Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For The Nine Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands)

	2008			2007
OPERATING ACTIVITIES
Net income	$	2,488		$	4,854
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		912			778
Amortization of intangibles		817			774
Other amortization		43			84
Provision for loan losses		2,307			438
Impairment charges on investments		570			-
Stock compensation expense		78			79
Deferred income taxes		865			116
Income on bank-owned life insurance		(519	)		(428	)
Gain on sales and calls of investment securities		(119	)		-
Increase in interest receivable		(711	)		(518	)
Increase in income taxes payable		747			195
Decrease in interest payable		(561	)		(215	)
Net gain on sale of loans		(251	)		(259	)
Originations of mortgage loans held for sale		(12,278	)		(9,307	)
Proceeds from sales of mortgage loans held for sale		12,367			9,583
Net loss on sale of other real estate		52			-
Increase in other assets		(538	)		(1	)
Increase in other liabilities		131			613
Net cash provided by operating activities		6,400			6,786
INVESTING ACTIVITIES
Proceeds from maturities of securities held to maturity		23,583			4,913
Purchases of securities held to maturity		(7,170	)		-
Purchases of securities available for sale		(31,479	)		(15,429	)
Proceeds from maturities of securities available for sale		26,114			16,536
Proceeds from sales of securities available for sale		-			1,003
Net change in restricted equity securities		(406	)		(65	)
Net increase in interest-bearing deposits in banks		(6,224	)		(6,153	)
Net increase in loans		(32,253	)		(15,332	)
Purchase of premises and equipment		(2,122	)		(2,384	)
Proceeds from sale of other real estate owned		852			-
Net cash and cash equivalents used in business combination		-			(6,147	)
Net cash used in investing activities		(29,105	)		(23,058	)

Subtotal carried forward		(22,705	)		(16,272	)

See Notes to Condensed Consolidated Financial Statements.

Index

SouthCrest Financial Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (continued)

For The Nine Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands)

	2008			2007

Subtotal brought forward	$	(22,705	)	$	(16,272	)

FINANCING ACTIVITIES
Net increase (decrease) in deposits		997			(263	)
Repayments of short-term borrowed funds		(3,055	)		(110	)
Increase in short-term borrowed funds		14,973			2,500
Net increase in federal funds purchased		609			772
Leveraged ESOP Transaction		23			-
Proceeds from other borrowings		-			4,000
Dividends paid		(1,532	)		(1,542	)
Net cash provided by financing activities		12,015			5,357
Net decrease in cash and cash equivalents		(10,690	)		(10,915	)
Cash and cash equivalents at beginning of year		25,376			29,430
Cash and cash equivalents at end of period	$	14,686		$	18,515

SUPPLEMENTAL DISCLOSURES
Cash paid for:
Interest	$	9,629		$	10,100
Income taxes		1,718			2,185
NONCASH TRANSACTIONS
Principal balances of loans transferred to other real estate owned	$	6,595		$	422
Increase in mortgage servicing rights		121			202
(Decrease) increase in redeemable common stock held by ESOP		(30	)		129
Unrealized (loss) gain on securities available for sale, net		(441	)		453
BUSINESS COMBINATION
Cash and due from banks, net of cash paid	$	-		$	3,103
Federal funds sold		-			8,100
Interest bearing deposits at other financial institutions		-			181
Securities available for sale		-			24,046
Restricted equity securities		-			257
Loans, net		-			26,344
Bank-owned life insurance		-			3,187
Premises and equipment		-			909
Goodwill		-			5,198
Core deposit intangible		-			715
Other assets		-			1,254
Total assets	$	-		$	73,294

Deposits	$	-		$	49,672
Federal Home Loan Bank advances		-			3,000
Other liabilities		-			3,272
Total liabilities assumed		-			55,944
Purchase price	$	-		$	17,350

See Notes to Condensed Consolidated Financial Statements.

Index

SouthCrest Financial Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1 — NATURE OF BUSINESS AND BASIS OF PRESENTATION

SouthCrest Financial Group, Inc. (“SouthCrest” or the “Company”) is a bank holding company whose principal activity is the ownership and management of its wholly owned subsidiary banks, Bank of Upson (“Upson”), The First National Bank of Polk County (“FNB Polk”), Peachtree Bank (“Peachtree”), and Bank of Chickamauga (“Chickamauga”). All of the subsidiary banks (collectively, the “Banks”) are commercial banks that provide a full range of banking services within their primary market areas. Upson is headquartered in Thomaston, Upson County, Georgia with seven branches located in Thomaston, Fayetteville, Tyrone Manchester, Warm Springs and Luthersville, Georgia, serving its primary market area of Upson, Fayette, Meriwether and the surrounding counties. FNB Polk is located in Cedartown, Polk County, Georgia with two branches in Cedartown, Georgia and one branch in Rockmart, Georgia. FNB Polk primarily serves the market area of Polk County. Peachtree is headquartered in Maplesville, Chilton County, Alabama with one branch in Maplesville and another in Clanton, Alabama. Chickamauga is headquartered in Chickamauga, Walker County, Georgia where it maintains two branches.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008. For further information, refer to the financial statements and notes included in the Company's consolidated financial statements and notes thereto for the year ended December 31, 2007 included in the Company’s annual report on Form 10-K (Registration No. 000-51287).

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Bank of Upson, The First National Bank of Polk County, Peachtree Bank, and Bank of Chickamauga. All significant inter-company accounts and transactions have been eliminated in consolidation. Certain reclassifications to prior year balance sheets and income statements have been made to conform to current classifications. These reclassifications have no impact on net income or stockholders’ equity reported for the previous year.

NOTE 2 – EARNINGS PER COMMON SHARE

Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares outstanding during the period. Diluted earnings per share would be computed by dividing net income by the sum of the weighted-average number of shares of common stock outstanding and dilutive potential common shares, such as outstanding stock options. Dilutive potential common shares are calculated in accordance with the treasury stock method, which assumes that proceeds from the exercise of all options are used to repurchase common stock at market value. The amount of shares remaining after the proceeds are exhausted represents the potentially dilutive effect of the securities.

At September 30, 2008 and 2007, the Company had 191,400 options outstanding under the SouthCrest Financial Group, Inc. 2005 Stock Incentive Plan. For the three and nine month periods ended September 30, 2008 and 2007, these options were nondilutive. The Company’s ESOP has a loan from the holding company secured by 14,821 shares of Company stock which have not been allocated to participant accounts and are therefore not considered outstanding for purposes of computing earnings per share. The weighted average number of shares outstanding for purposes of computing earnings per share was 3,916,707 and 3,952,328 for the three months ended September 30, 2008 and 2007, and 3,916,239 and 3,952,328 for the nine months ended September 30, 2008 and 2007.

Index

NOTE 3 — LOANS RECEIVABLE

The composition of loans at September 30, 2008 and December 31, 2007 is summarized as follows:

	September 30,			December 31,
(Dollars in thousands)	2008			2007
Commercial, financial, and agricultural	$	24,134		$	22,595
Real estate – construction		69,574			66,069
Real estate – mortgage		259,934			241,316
Consumer		37,050			38,834
Other		7,781			5,162
		398,473			373,976
Unearned income		(14	)		(151	)
Allowance for loan losses		(6,189	)		(4,952	)
Loans, net	$	392,270		$	368,873

Changes for the nine months ended in the allowance for loan losses are as follows:

	September 30,			September 30,
(Dollars in thousands)	2008			2007
Balance, beginning of year	$	4,952		$	4,480
Provision for loan losses		2,307			438
Loans charged off		(1,516	)		(600	)
Recoveries of loans previously charged off		446			472
Allowance acquired in business combination		-			344
Balance, end of period	$	6,189		$	5,134

The following is a summary of information pertaining to impaired loans:

	September 30,		December 31,
(Dollars in thousands)	2008		2007
Impaired loans without a valuation allowance	$	-	$	-
Impaired loans with a valuation allowance		5,654		1,633
Total impaired loans	$	5,654	$	1,633
Valuation allowance related to impaired loans	$	908	$	245
Average investment in impaired loans	$	5,109	$	507

There were $5,654,000 and $1,633,000 loans on nonaccrual status at September 30, 2008 and December 31, 2007. Loans of $454,000 and $247,000 were past due ninety days or more and still accruing interest at September 30, 2008 and December 31, 2007, respectively.

	September 30,		December 31,
(Dollars in thousands)	2008		2007
Nonaccrual loans	$	5,654	$	1,633
Loans past due 90 days or more and still accruing	$	454	$	247
Loans restructured under troubled debt	$	163	$	-

NOTE 4 — INVESTMENT SECURITIES IMPAIRMENT

In the quarter ended September 30, 2008, the Company recorded an impairment charge of $570,000 on $640,000 of Federal National Mortgage Association (“Fannie Mae”) perpetual preferred stock. The reclassification of an unrealized mark-to-market loss on these securities to an other-than-temporary impairment charge was the result of action taken by the federal government to take Fannie Mae into conservatorship. Losses on the securities were previously recognized in the equity section of the balance sheet.

Index

NOTE 5 — DEPOSITS

At September 30, 2008 and December 31, 2007, deposits were as follows:

	September 30,		December 31,
(Dollars In Thousands)	2008		2007

Noninterest bearing deposits	$	76,024	$	80,685
Interest checking		95,823		83,742
Money market		54,060		55,687
Savings		43,371		41,997
Certificates of deposit		245,719		251,820
	$	514,997	$	513,931

NOTE 6 — NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB ratified EITF Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF Issue 06-4 addresses accounting for split-dollar life insurance arrangements after the employer purchases a life insurance policy on the covered employee. This Issue states that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits. Under Issue EITF 06-4, the obligation is not settled upon entering into an insurance arrangement. Since the obligation is not settled, a liability should be recognized in accordance with applicable authoritative guidance. Issue EITF 06-4 is effective for fiscal years beginning after December 15, 2007. In adopting EITF Issue 06-4, the Company recorded a liability of $493,000 as of January 1, 2008 with a corresponding offset against retained earnings, and in the three months and nine months ended September 30, 2008 recorded compensation expense of approximately $25,000 and $75,000, respectively, relating to these obligations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities. SFAS No. 159 allows an entity to elect to measure certain financial assets and liabilities at fair value with changes in fair value recognized in the income statement each period. The statement also requires additional disclosures to identify the effects of an entity’s fair value election on its earnings. The Company adopted SFAS No. 159 on January 1, 2008, with no material impact on the financial condition, results of operations, or liquidity. The Company did not elect fair value for any assets or liabilities.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R) will significantly change how entities apply the acquisition method to business combinations. The most significant changes affecting how the Company will account for business combinations under this Statement include: the acquisition date will be date the acquirer obtains control; all (and only) identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree will be stated at fair value on the acquisition date; assets or liabilities arising from noncontractual contingencies will be measured at their acquisition date fair value only if it is more likely than not that they meet the definition of an asset or liability on the acquisition date; adjustments subsequently made to the provisional amounts recorded on the acquisition date will be made retroactively during a measurement period not to exceed one year; acquisition-related restructuring costs that do not meet the criteria in SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, will be expensed as incurred; transaction costs will be expensed as incurred; reversals of deferred income tax valuation allowances and income tax contingencies will be recognized in earnings subsequent to the measurement period; and the allowance for loan losses of an acquiree will not be permitted to be recognized by the acquirer. Additionally, SFAS No. 141(R) will require new and modified disclosures surrounding subsequent changes to acquisition-related contingencies, contingent consideration, noncontrolling interests, acquisition-related transaction costs, fair values and cash flows not expected to be collected for acquired loans, and an enhanced goodwill rollforward.

The Company will be required to prospectively apply SFAS No. 141(R) to all business combinations completed on or after January 1, 2009. Early adoption is not permitted. For business combinations in which the acquisition date was before the effective date, the provisions of SFAS No. 141(R) will apply to the subsequent accounting for deferred income tax valuation allowances and income tax contingencies and will require any changes in those amounts to be recorded in earnings. At September 30, 2008, the Company had no acquired deferred income tax valuation allowances and income tax contingencies. Management is currently evaluating the effects that SFAS 141(R) will have on the financial condition, results of operations, liquidity, and the disclosures that will be presented in the consolidated financial statements.

Index

In November 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings, which expressed the staff’s view that, consistent with FASB Statement No. 156, Accounting for Servicing of Financial Assets, and FASB Statement No. 159, The Fair Value Option of Financial Assets and Financial Liabilities, the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SAB No. 109 is effective for all written loan commitments recorded at fair value that are entered into, or substantially modified, in fiscal quarters beginning after December 15, 2007. The staff expects registrants to apply the views of SAB No. 109 on a prospective basis. The effect of adoption during the first quarter of 2008 did not have a material impact on the Company’s results of operations.

In April 2008, the FASB issued FASB Staff Position ("FSP") No. SFAS 142-3, Determination of the Useful Life of Intangible Assets. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). This FSP applies to all intangible assets, whether acquired in a business combination or otherwise and shall be effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. The Company will adopt the provisions of FSP No. SFAS 142-3 in the first quarter of 2009, as required, but does not expect the impact to be material to the Company’s financial condition or results of operations.

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This FSP addresses whether such instruments are participating securities prior to vesting and, therefore, need to be included in the EPS calculation under the two-class method described in paragraphs 60 and 61 of SFAS No. 128, Earnings per Share. This FSP is effective for fiscal years beginning after December 15, 2008. Management does not expect the adoption of FSP EITF 03-6-1 to have an impact on the consolidated financial statements of the Company.

In October 2008, the FASB issued FSP No. 157-3 , Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. This FSP clarifies the application of SFAS No. 157 in a market that is not active and applies to financial assets within the scope of accounting pronouncements that require or permit fair value measurements in accordance with Statement 157. This FSP also provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This FSP was effective upon issuance on October 10, 2008 and includes periods for which financial statements have not yet been issued. The adoption of FSP No. 157-3 did not have a material impact on the consolidated financial statements of the Company.

NOTE 7 - FAIR VALUE

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements, (SFAS No. 157), which defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States, and enhances disclosures about fair value measurements. SFAS No. 157 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments would typically involve application of lower of cost or market accounting or write-downs of individual assets.

SFAS 157 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1

Observable inputs such as quoted prices in active markets;

Level 2

Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3

Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Index

Following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities

Securities available for sale and securities held to maturity are valued on a recurring basis at quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities and debentures issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets and some common stock not traded on a national exchange. Securities held to maturity are valued at quoted market prices or dealer quotes, similar to securities available for sale. The carrying value of Federal Reserve Bank and Federal Home Loan Bank stock approximates fair value based on their redemption provisions.

Loans Held for Sale

Loans held for sale, consisting of mortgages to be sold in the secondary market, are carried at the lower of cost or market value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustments for mortgage loans held for sale is nonrecurring Level 2.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan may be considered impaired and an allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, (“SFAS No. 114”). The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2008, all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS No. 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.

	Fair Value September 30,		Quoted Prices In Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(Dollars in thousands)	2008		(Level 1)		(Level 2)		(Level 3)

Securities available for sale	$	83,397	$	29	$	83,187	$	181

The securities measured as Level 3 include investment in the common stock of a bank holding company that is not listed on an exchange. Its fair value is measured as a factor of book value. There were no gains or losses for the three and nine months ended September 30, 2008 included in earnings that are attributable to the change in unrealized gains or losses of the Company’s securities available for sale at September 30, 2008.

For those securities available for sale with fair values that are determined by reliance on significant unobservable inputs, the following table identifies the factors causing the change in fair value from January 1, 2008 to September 30, 2008:

Index

	Investment Securities
	Available For Sale

Beginning balance, January 1, 2008	$	280
Total gains (losses) realized or unrealized Included in earnings		-
Included in other comprehensive income		(99	)
Transfers in (out) of Level 3		-
Ending balance, September 30, 2008	$	181

The table below presents the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis.

	Fair Value September 30,		Quoted Prices In Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(Dollars in thousands)	2008		(Level 1)		(Level 2)		(Level 3)

Impaired loans	$	4,746	$	-	$	-	$	4,746

The values of loans held for sale are based on prices observed for similar pools of loans, appraisals provide by third parties and prices determined based on terms of investor purchase commitments. The value of impaired loans is determined by the estimated collateral value or by the discounted present value of the expected cash flows.

NOTE 8 — BORROWED FUNDS

At September 30, 2008, the Company had $6,555,000 outstanding on its line of credit with Silverton Bank, N.A. (formerly The Bankers Bank). The stock of our subsidiary banks is pledged as collateral for this loan. The loan contains certain restrictive covenants including, among others, a requirement for each subsidiary bank to maintain certain minimum capital levels as well as maximum ratios related to the levels of nonperforming assets. At September 30, 2008, the ratio of nonperforming assets (which includes nonaccrual loans, loans 90 days or more past due and still accruing, and other real estate) to total assets for the four bank subsidiaries ranged from 1.39% to 2.11% which was in excess of the 1.00% allowed under the Loan and Stock Pledge Agreement. At June 30, 2008, the Company was in violation of the covenant, and the Company obtained a waiver of covenant from Silverton Bank. The Company is working with Silverton to obtain a waiver for the quarter ended September 30, 2008. If the Company remains outside this covenant and is unable to obtain a waiver or amendment of the loan agreement, Silverton Bank would have the right to give notice of default. If the Company is unable to cure the default within fifteen days of notice, then Silverton Bank would have the right to declare the entire balance of the loan due and payable, which could have a material adverse effect on the Company's liquidity and ability to pay dividends. Management intends to continue to vigorously pursue a favorable resolution to this issue, which in addition to the alternatives above, would include repayment of the loan through a payment of special dividends from the subsidiary banks, obtaining financing from another lender, or a combination of the two.

Index

SouthCrest Financial Group, Inc. and Subsidiaries

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of certain significant factors which have affected the financial position and operating results of SouthCrest Financial Group, Inc. and its bank subsidiaries, Bank of Upson, The First National Bank of Polk County, Peachtree Bank, and Bank of Chickamauga during the period included in the accompanying consolidated financial statements. The purpose of this discussion is to focus on information about our financial condition and results of operations that are not otherwise apparent from our consolidated financial statements.

Forward Looking Statements

Some of the statements in this Report, including, without limitation, matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” of SouthCrest Financial Group, Inc. are “forward-looking statements” within the meaning of the federal securities laws. Forward-looking statements include statements about the competitiveness of the banking industry, potential regulatory obligations, our entrance and expansion into other markets, integration of recently acquired banks, pending or proposed acquisitions, our other business strategies, our expectations with respect to our allowance for loan losses and impaired loans, anticipated capital expenditures for our operations center, and other statements that are not historical facts. When we use words like “anticipate,” “believe,” “intend,” “expect,” “estimate,” “could,” “should,” “will,” and similar expressions, you should consider them as identifying forward-looking statements, although we may use other phrasing. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions, and on the information available to us at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements include, among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) changes in the interest rate environment may reduce margins; (3) general economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and/or a reduction in demand for credit; (4) legislative or regulatory changes, including changes in accounting standards may adversely affect the businesses in which we are engaged; (5) costs or difficulties related to the integration of our businesses, may be greater than expected; (6) deposit attrition, customer loss or revenue loss following acquisitions may be greater than expected; (7) competitors may have greater financial resources and develop products that enable such competitors to compete more successfully than us; and (8) adverse changes may occur in the equity markets.

Many of such factors are beyond our ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. We disclaim any obligation to update or revise any forward-looking statements contained in this Report, whether as a result of new information, future events or otherwise.

Critical Accounting Estimates

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the notes to the consolidated financial statements for the year ended December 31, 2007 included in our Form 10-K (Registration No. 000-51287). Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting judgments and assumptions to be our critical accounting estimates. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

We believe the allowance for loan losses is a critical accounting estimate that requires the most significant judgments and assumptions used in preparation of our consolidated financial statements. Because the allowance for loan losses is replenished through a provision for loan losses that is charged against earnings, our subjective determinations regarding the allowance affect our earnings directly. Refer to the portion of this discussion that addresses our allowance for loan losses for a description of our processes and methodology for determining our allowance for loan losses.

The consolidated financial statements include certain accounting and disclosures that require management to make estimates about fair values. Estimates of fair value are used in the accounting for securities available for sale, loans held for sale, stock compensation, intangible assets, and acquisition purchase accounting adjustments. Estimates of fair values are used in disclosures regarding securities held to maturity, stock compensation, commitments, and the fair values of financial instruments. Fair values are estimated using relevant market information and other assumptions such as interest rates, credit risk, prepayments and other factors. The fair values of financial instruments are subject to change as influenced by market conditions. Goodwill must be periodically evaluated for potential impairment based on fair value assessments.

Index

Financial Condition

During the nine months ended September 30, 2008, our total assets increased $14.5 million to $620.5 million at September 30, 2008. During this period, total loans increased $23.4 million, or 6.3%. Securities available for sale increased $5.8 million due primarily to purchases made during the period while securities held to maturity decreased $18.1 million due to maturities. Interest bearing deposits at other financial institutions increased $6.2 million, or 58.5%. At September 30, 2008 the Company owned $15.4 million in certificates of deposits in other financial institutions, which are structured so that all principal and accrued interest remain fully insured under FDIC deposit insurance. The Company limits these deposits so that, at maturity, the principal value plus interest earned are less than $100,000. Federal funds sold decreased $9.2 million.

During the year to date period ended September 30, 2008, deposits increased $1.1 million or 0.2%. Changes in deposits are summarized below:

	September 30,		December 31,
(Dollars In Thousands)	2008		2007		Change

Noninterest bearing deposits	$	76,024	$	80,685	$	(4,661	)
Interest checking		95,823		83,742		12,081
Money market		54,060		55,687		(1,627	)
Savings		43,371		41,997		1,374
Certificates of deposit		245,719		251,820		(6,101	)
	$	514,997	$	513,931	$	1,066

At September 30, 2008, short-term borrowed funds consist of $14,973,000 in Federal Home Loan Bank advances and $609,000 of federal funds purchased. At December 31, 2007, short-term borrowed funds consisted of $3,055,000 in Federal Home Loan Bank advances which were repaid in the current year. The Company monitors changes in its loan portfolio and changes in its deposit levels, and seeks to maintain a proper mix of types, maturities, and interest rates.

Our total stockholders’ equity increased by $153,000 since December 31, 2007, due to net income of $2,488,000 offset by dividends paid of $1,533,000, a $493,000 adjustment to beginning retained earnings related to the implementation of EITF Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangement, and a $441,000 decrease in the unrealized gain on securities available for sale, net of deferred taxes.

Loan Portfolio. The following table presents various categories of loans contained in the loan portfolios of the subsidiary banks as of September 30, 2008 and December 31, 2007:

	September 30,			December 31,
(Dollars in thousands)	2008			2007
Commercial, financial, and agricultural	$	24,134		$	22,595
Real estate – construction		69,574			66,069
Real estate – mortgage		259,934			241,316
Consumer		37,050			38,834
Other		7,781			5,162
		398,473			373,976
Unearned income		(14	)		(151	)
Allowance for loan losses		(6,189	)		(4,952	)
Loans, net	$	392,270		$	368,873

Index

Nonaccrual, Past Due and Restructured Loans. The following table presents various categories of nonaccrual, past due, and restructured loans in the Banks’ loan portfolios as of September 30, 2008 and December 31, 2007:

	September 30,		December 31,
(Dollars in thousands)	2008		2007
Nonaccrual loans	$	5,654	$	1,633
Loans past due 90 days or more and still accruing	$	454	$	247
Loans restructured under troubled debt	$	163	$	-

Nonaccrual loans decreased $5,459,000 during the quarter ended September 30, 2008, declining from $11,113,000 at June 30, 2008 to $5,654,000 at September 30, 2008. Since December 31, 2007, nonaccrual loans have increased $4,021,000. The decrease in nonaccrual loans for the quarter is attributed to the transfer of a $5.5 million residential real estate development loan to other real estate. Nonaccrual loans at September 30, 2008 include a $3.45 million loan for the construction and development of an apartment complex, a $376,000 nonresidential construction loan, a $663,000 residential development loan secured by a property in Arizona, and $1,415,000 in loans secured by first mortgage loans on single family dwellings, the largest of which was $249,000. In total, the Company has recorded a valuation allowance of $908,000 related to nonaccrual loans at September 30, 2008.

Information regarding impaired loans as of September 30, 2008 and December 31, 2007 are as follows:

	September 30,		December 31,
(Dollars in thousands)	2008		2007
Impaired loans without a valuation allowance	$	-	$	-
Impaired loans with a valuation allowance		5,654		1,633
Total impaired loans	$	5,654	$	1,633
Valuation allowance related to impaired loans	$	908	$	245
Average investment in impaired loans	$	5,109	$	507

In addition to the above, the Company had at September 30, 2008 $15,579,000 in potential problem loans. Potential problem loans are loans which are currently performing but as to which information about the borrowers' possible credit problems causes management to have doubts about their ability to comply with current repayment terms. Management has downgraded these loans and closely monitors their continued performance. The following is a summary of our potential problem loans at September 30, 2008:

(Dollars in thousands)
Construction and development loans	$	5,049
First mortgage - residential		5,532
Second mortgage and home equity line of credit		275
Nonresidential mortgage		4,028
Commercial		227
Consumer		468

Total	$	15,579

Construction and development loans includes a $2,000,000 loan for the development of a retail shopping center. Subsequent to September 30, 2008, the developer for the project filed for involuntary bankruptcy. The Company believes the loan is adequately collateralized. In addition, construction and development loans includes a $1,470,000 loan secured by 74 lots in a townhome development. First mortgage residential loans are composed of 81 loans, the largest of which is $227,000. There are 20 loans whose balance is greater than $100,000, which account for $2,975,000 of the total. Loans secured by nonresidential real estate are composed of 15 loans, the largest of which is a $2,600,000 loan secured by a retail shopping center.

Other Real Estate. Included in other assets was other real estate of $5,947,000 and $256,000 as of September 30, 2008 and December 31, 2007, respectively. The increase in other real estate is generally attributable to slowing economic conditions resulting in increased foreclosures. At September 30, 2008 $4,925,000 of the other real estate includes property composed of 96 developed and 24 partially developed lots in a golf course development. This property was foreclosed in September, 2008 and related to a loan that was classified as nonaccrual at March 31 and June 30, 2008. The remainder of other real estate consists of six residential properties, the largest having a balance of $316,000.

Index

Summary of Loan Loss Experience. An analysis of SouthCrest’s loan loss experience is included in the following table for the periods ended September 30, 2008 and 2007:

Analysis of Allowance for Loan Losses

For The Three and Six Months Ended September 30

(Dollars in thousands)	Three Months						Nine Months
	2008			2007			2008			2007

Balance at beginning of period	$	6,206		$	4,674		$	4,952		$	4,480
Chargeoffs
Commercial loans		3			25			44			72
Real estate - construction		616			-			638			-
Real estate - mortgage		76			41			180			41
Consumer		286			158			566			397
Other		29			32			88			90
Total Chargeoffs		1,010			256			1,516			600

Recoveries
Commercial loans		12			1			19			27
Real estate - construction		1			40			25			40
Real estate - mortgage		2			8			43			12
Consumer		120			101			294			334
Other		21			10			65			59
Total recoveries		156			160			446			472

Net chargeoffs		(854	)		(96	)		(1,070	)		(128	)
Additions charged to operations		837			212			2,307			438
Additions to allowance resulting from business combination		-			344			-			344

Balance at end of period	$	6,189		$	5,134		$	6,189		$	5,134

Annualized ratio of net chargeoffs during the period to average loans outstanding during the period		0.89	%		0.10	%		0.37	%		0.05	%

Allowance for Loan Losses. The allowance for loan losses as of September 30, 2008 was $6,189,000 compared to $4,952,000 at December 31, 2007 and $5,134,000 at September 30, 2007. As a percentage of gross loans, the allowance for loan losses was 1.55% at September 30, 2008 compared to 1.32% as of December 31, 2007 and 1.36% at September 30, 2007. During the current quarter, chargeoffs totaled $1,010,000 which includes $616,000 relating to a loan secured by residential lots foreclosed in September. Management’s estimate of the allowance for loan losses utilizes a loan grading system to assign a risk grade to each loan based on factors such as the quality of collateral securing a loan, the financial condition of the borrower and the payment history of each loan. Based on net charge-off history experienced for each category within the loan portfolio, as well as general economic factors affecting the lending market, management assigns an estimated allowance for each risk grade within each of the loan categories. Management then estimates the required allowance, which may also include a portion that is not allocated to a specific category of the loan portfolio, but which management deems is necessary based on the overall risk inherent in the loan portfolio. The estimation of the allowance may change due to fluctuations in the factors noted above as well as changes in the trends of net charge-offs, past due loans, and general economic conditions of the markets served by the Company’s subsidiary banks.

Management considers the allowance for loan losses to be adequate; however, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional provisions of the allowance will not be required.

Results of Operations For The Three and Nine Months Ended September 30, 2008 and 2007

Net income for the three-month period ended September 30, 2008 amounted to $476,000, or $0.12 basic and diluted earnings per share, compared to net income of $1,650,000 or $0.42 basic and diluted earnings per share for the same three-month period in 2007, a decrease of $1,174,000, or 71.2%. Net income for the nine-month period ended September 30, 2008 amounted to $2,488,000, or $0.64 basic and diluted earnings per share, compared to net income of $4,854,000 or $1.23 basic and diluted earnings per share for the same nine-month period in 2007, a decrease of $2,366,000, or 48.7%. For both the three-month and nine-month period, the decline in net income is generally attributable to reductions in net interest income, increases in the provision for loan losses, and an other than temporary impairment loss on investment securities.

Index

The acquisition of Bank of Chickamauga was made on July 1, 2007 and results of operations for Chickamauga are only included in consolidated results prospectively from the date of merger. Therefore, the year to date results of operations for 2007 do not include Chickamauga for the first six months of the year.

Net Interest Income. Net interest income represents the difference between interest received on interest earning assets and interest paid on interest bearing liabilities. The following presents, for the three month periods ended September 30, 2008 and 2007, the main components of interest earning assets and interest bearing liabilities and related interest income and expense and effective yields and cost of funds.

Average Consolidated Balance Sheets and Net Interest Income Analysis

For the Three Month Periods Ended September 30,

(Dollars in thousands)

	Average Balances (1)						Yields / Rates						Income / Expense				Increase			Change Due to
	2008			2007			2008			2007			2008		2007		(Decrease)			Rate			Volume
Assets
Loans, including fee income	$	385,974		$	369,857			7.13	%		8.41	%	$	6,915	$	7,840	$	(925	)	$	(1,246	)	$	321
Taxable securities		112,558			126,625			4.73	%		4.77	%		1,339		1,521		(182	)		(13	)		(169	)
Nontaxable securities		23,480			24,489			3.90	%		3.90	%		230		241		(11	)		-			(11	)
Federal funds sold		9,957			8,175			0.80	%		5.87	%		20		121		(101	)		(122	)		21
Interest bearing deposits in banks		15,141			7,029			4.07	%		5.19	%		155		92		63			(24	)		87
Total earning assets		547,110			536,175			6.30	%		7.26	%		8,659		9,815		(1,156	)		(1,405	)		249
Cash and due from banks		15,031			15,379
Allowance for loan losses		(5,781	)		(5,059	)
Other assets		62,159			56,239
Total	$	618,519		$	602,734

Liabilities and Equity
Interest bearing demand (2)	$	149,593		$	133,037			1.39	%		1.87	%	$	524	$	628	$	(104	)	$	(174	)	$	70
Savings		44,141			45,393			0.70	%		0.75	%		78		86		(8	)		(6	)		(2	)
Certificates of deposit		252,144			246,868			3.83	%		4.77	%		2,426		2,968		(542	)		(603	)		61
Total interest bearing deposits		445,878			425,298			2.70	%		3.43	%		3,028		3,682		(654	)		(783	)		129
Borrowed funds		11,124			15,614			4.36	%		5.82	%		122		229		(107	)		(50	)		(57	)
Total interest bearing liabilities		457,002			440,912			2.74	%		3.52	%		3,150		3,911		(761	)		(833	)		72
Noninterest bearing demand deposits		78,477			81,835
Other liabilities		10,170			281
Redeemable common stock held by ESOP		712			1,062
Shareholders' equity		72,158			78,644
Total	$	618,519		$	602,734
Net interest income													$	5,509	$	5,904	$	(395	)	$	(572	)	$	177
Net interest margin								4.01	%		4.37	%
Net interest spread								3.56	%		3.74	%

Index

Net interest income for the three months ended September 30, 2008 decreased $395,000 or 6.7% over the same period in 2007. The $395,000 decline in net interest income attributable to a $572,000 reduction attributable to changes in interest rates was offset by an increase of $177,000 attributable to increases in the average balances of interest earning assets and interest bearing liabilities. Beginning in August 2007, the Federal Reserve has announced several reductions in the discount rate, with the result being that the average discount rate for the period ending September 30, 2008 was approximately 250 basis points lower than the same period in 2007. These reductions have contributed to a reduction in the average yield on earning assets from 7.26% during the three month period ending September 30, 2007 to 6.30% in the same period in 2008. The average cost of funds declined from 3.52% in 2007 to 2.74% in 2008. The net interest margin declined 36 basis points from 4.37% for the quarter ended September 30, 2007 to 4.01% for the current year period. The net interest spread decreased from 3.74% in 2007 to 3.56% in 2008. Total interest income decreased $1,156,000 to $8,659,000 for the quarter ended September 30, 2008. Interest income earned on loans decreased $925,000 composed of a $1,246,000 reduction in interest due to the reduction in the average yield of the loan portfolio from 8.41% to 7.13%, offset by a $321,000 increase that relates to a $16.1 million growth in the average balance of loans. The reduction in the average yield on loans results from a significant portion of the loan portfolio having variable interest rates that are tied to the prime rate. We expect that our net interest margin and net interest spread to face continued pressure as the Federal Reserve further reduces the discount rate.

Interest expense decreased $761,000 to $3,150,000 for the quarter ended September 30, 2008. The main component of the decrease in interest expense was a $542,000 decrease in interest paid on certificates of deposits. Since 2005, the Company has generally funded the growth in its loan portfolio with borrowed funds, primarily Federal Home Loan Bank advances, and with certificates of deposit. These sources of funds typically carry higher rates of interest than other sources of funds such as checking and money market accounts. The average rate on certificates of deposits typically lags the changes in the discount rate due to the longer term of the accounts and to competition from other banks for such funds.

The following presents, for the nine month periods ended September 30, 2008 and 2007, the main components of interest earning assets and interest bearing liabilities and related interest income and expense and effective yields and cost of funds.

Index

Average Consolidated Balance Sheets and Net Interest Income Analysis

For the Nine Month Periods Ended September 30,

(Dollars in thousands)

	Average Balances (1)						Yields / Rates						Income / Expense				Increase			Change Due to
	2008			2007			2008			2007			2008		2007		(Decrease)			Rate			Volume
Assets
Loans, including fee income	$	383,165		$	345,621			7.35	%		8.38	%	$	21,088	$	21,654	$	(566	)	$	(2,806	)	$	2,240
Taxable securities		113,039			118,541			4.82	%		4.73	%		4,081		4,190		(109	)		82			(191	)
Nontaxable securities		23,475			20,342			3.91	%		3.90	%		688		594		94			2			92
Federal funds sold		12,155			8,903			2.59	%		5.27	%		236		351		(115	)		(217	)		102
Interest bearing deposits in banks		14,398			5,748			3.76	%		6.16	%		405		265		140			(135	)		275
Total earning assets		546,232			499,155			6.48	%		7.25	%		26,498		27,054		(556	)		(3,074	)		2,518
Cash and due from banks		15,010			13,880
Allowance for loan losses		(5,575	)		(4,772	)
Other assets		61,876			51,069
Total	$	617,543		$	559,332

Liabilities and Equity
Interest bearing demand (2)	$	149,032		$	129,212			1.49	%		1.85	%	$	1,657	$	1,788	$	(131	)	$	(381	)	$	250
Savings		44,064			39,192			0.72	%		0.72	%		237		212		25			-			25
Certificates of deposit		252,601			223,851			4.21	%		4.72	%		7,966		7,900		66			(900	)		966
Total interest bearing deposits		445,697			392,255			2.96	%		3.37	%		9,860		9,900		(40	)		(1,281	)		1,241
Borrowed funds		10,093			9,651			4.37	%		5.75	%		330		415		(85	)		(103	)		18
Total interest bearing liabilities		455,790			401,906			2.99	%		3.43	%		10,190		10,315		(125	)		(1,384	)		1,259
Noninterest bearing demand deposits		78,516			79,521
Other liabilities		10,247			5,011
Redeemable common stock held by ESOP		782			1,054
Shareholders' equity		72,208			71,840
Total	$	617,543		$	559,332
Net interest income													$	16,308	$	16,739	$	(431	)	$	(1,690	)	$	1,259
Net interest margin								3.99	%		4.48	%
Net interest spread								3.49	%		3.82	%

(1) Daily averages. Loans includes nonaccrual loans.

(2) Includes money market accounts

Net interest income for the nine months ended September 30, 2008 decreased $431,000 or 0.3% over the same period in 2007. The $431,000 decline in net interest income is attributable to a $1,690,000 decline relating to changes in interest rates offset by a $1,259,000 increase in interest expense relating to changes in the average balances of interest earning assets and interest bearing liabilities. As a result of Federal Reserve reductions in the discount rate, the average discount rate for the nine-month period ending September 30, 2008 was approximately 344 basis points lower than the same period in 2007. These reductions have contributed to a reduction in the average yield on earning assets from 7.25% during the nine month period ending September 30, 2007 to 6.48% in the same period in 2008. During the same period, the average cost of funds declined from 3.43% in 2007 to 2.99% in 2008. The net interest margin declined 49 basis points from 4.48% for the period ended September 30, 2007 to 3.99% for the current year period. The net interest spread decreased from 3.82% in 2007 to 3.49% in 2008. We expect that our net interest margin and net interest spread to face continued pressure as the Federal Reserve further reduces the discount rate.

Index

Total interest income decreased $556,000 to $26.5 million for the nine-month period ended September 30, 2008. Interest income earned on loans decreased $566,000. Of this decrease, $2,806,000 relates to reduction in interest due to the reduction in the average yield of the loan portfolio from 8.38% to 7.35%, caused by a significant portion of the loan portfolio having variable interest rates that are tied to the prime rate. Offsetting this decrease was a $2,240,000 increase in interest due to the $37.5 million growth in the average balance of loans.

Interest expense decreased $125,000 to $10.2 million for the nine-month period ended September 30, 2008 primarily due to reductions in the levels of rates paid for funds. The main component of the decrease in interest expense was a decrease in interest paid on interest bearing demand deposits. The average rate on these funds decreased from 1.85% in 2007 to 1.49% for the 2008 period, and the average balance increased $19.8 million.

Other Income. Total other income for the three-month period ended September 30, 2008 amounted to $1,170,000, compared to $1,788,000 for the same period in 2007, a decrease of $618,000. For the nine-month period, total other income was $4,932,000 compared to $4,892,000 in 2007, an increase of $40,000. The addition of Bank of Chickamauga accounted for $303,000 of additional other income for the nine-month period.

Service charges (including NSF and overdraft charges) on deposit accounts decreased $11,000 or 1.1% for the three-month period and increased $216,000 or 7.8% for the nine-month period. As a percentage of interest-bearing and non-interest bearing checking accounts, these service charges were 1.79% and 1.92% for the three-month periods ended September 30, 2008 and 2007 and 1.75% and 1.77% for the nine-month periods in 2008 and 2007, respectively. Other service charges and fees increased $57,000 for the three-month period in 2008 and $191,000 for the nine month period. For the three month period, the increase results primarily from a $38,000 increase in debit card fees and a $47,000 increase in ATM fee income. For the nine month period, debit card fees increased $96,000 and ATM fee income increased $28,000. The change applicable to the addition of Chickamauga accounted for approximately $50,000 of the increase.

Gain on sale of loans was $31,000 for the three months ended September 30, 2008 compared to $112,000 in 2007 due to decreased volume of loans sold. Included in the gain on sale of loans are mortgage servicing rights of $17,000 and $72,000 for the three month periods ended September 30, 2008 and 2007, respectively. For the nine-month period, gain on sale of loans was $251,000 compared to $350,000 in 2007, including recognition of mortgage servicing rights of $121,000 and $202,000. The following presents the activity in the Company’s mortgage servicing rights in 2008 and 2007:

	Three Months						Nine Months
(dollars in thousands)	2008			2007			2008			2007

Beginning balance	$	556		$	465		$	510		$	375
Servicing rights recognized		17			60			121			202
Amortization expense		(34	)		(39	)		(92	)		(91	)
Ending balance	$	539		$	486		$	539		$	486

In the third quarter, the Company recorded a $570,000 impairment loss on its investment of preferred stock of the Federal National Mortgage Association (“Fannie Mae”). The loss was recognized as Fannie Mae was taken into conservatorship by the federal government in September. The securities were written down to their estimated fair value as of September 30. In 2008, the Company recorded gains calls of securities of $-0- and $119,000 for the three and nine month periods ended September 30, 2008. The securities were called as the reduction in the levels of interest rates made it advantageous for the issuers of the debt securities to redeem the securities.

Income from bank-owned life insurance increased $2,000 during the three-month period, and $91,000 for the nine-month period. The increase for the nine-month period includes $76,000 which relates to the insurance policies assumed in the acquisition of Bank of Chickamauga.

Other Expenses. Other expenses for the three-month period ended September 30, 2008 amounted to $5,388,000 compared to $5,120,000 for the same period in 2007, an increase of $268,000 or 5.2%. For the nine-month period, total other expenses were $15,782,000 compared to $14,165,000 for the same period in 2007, an increase of $1,617,000 or 11.4%. The acquisition of Chickamauga accounted for $1,080,000 of the increase for the nine month period.

The largest component of other expenses is salaries and employee benefits, which increased $99,000, or 3.5%, for the three-month period and $889,000 or 11.4% for the nine month period ended September 30, 2008. The acquisition of Chickamauga accounted for $556,000 of the increase for the nine month period. Excluding the impact of acquisitions, salaries and employee benefits increased 532,000 or 6.8% for the nine month period. Costs associated with the implementation of EITF Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements accounted for $25,000 of the increase for the three months and $75,000 for the nine month period. Other increases are related to merit increases and branch expansion. The compensation cost that was charged against income for our stock option plans was $26,000 for each of the three month periods ended September 30, 2008 and 2007, and $79,000 for each of the nine month periods. The total compensation cost related to nonvested awards not yet recognized at September 30, 2008 is $246,000 which will be recognized over the weighted average period of approximately 2.38 years.

Index

Amortization of intangibles did not change for the three month periods and increased $43,000 for the nine month periods due to the acquisition of Chickamauga. Equipment and occupancy expenses increased $103,000 for the quarter and $356,000 for the year to date. The acquisition of Chickamauga accounts for $87,000 of the year to date increase. Occupancy expenses increased $103,000 for the three-month period which includes $41,000 of higher depreciation costs and $23,000 in increased rent expense relating to branch expansion. For the year to date periods, depreciation expense increased $134,000. Other operating expenses increased $66,000 for the three month period and $329,000 for the nine month period. For the nine month period, $389,000 relates to the acquisition of the Bank of Chickamauga.

As a percentage of average total assets, other expenses were 3.47% and 3.38% of for the three month periods ended September 30, 2008 and 2007, and 3.41% and 3.38% for the nine-month periods ended September 30, 2008 and 2007, respectively.

Income Taxes. The Company recorded an income tax benefit of $22,000 and income tax expense of $710,000 for the three month periods ended September 30, 2008 and 2007. Effective tax rates for the three month periods ended September 30, 2008 and 2007 were (4.8%) and 30.6%, respectively. For the nine-month periods ended September 30, 2008 and 2007, income tax expense was $663,000 and $2,174,000, respectively, with effective tax rates of 21.0% and 31.3%. Tax-exempt interest income and income on bank-owned life insurance are the primary reasons that the Company’s effective tax rates are less than the statutory tax rate of 34%. Effective tax rates are lower in 2008 than in 2007 as tax exempt income represented 88.1% of income before income taxes for the three-month period in 2008 compared to 17.3% for the same period in 2007, and 38.3% for the nine-month period in 2008 compared to 14.5% for the same period in 2007. During the quarter ended September 30, 2008 the Company recorded a tax benefit related to the other than temporary impairment charge for the Fannie Mae preferred stock as the Company had sufficient capital gains to carryback and capital gain tax planning strategies to offset the loss.

Liquidity and Capital Resources

Liquidity is our ability to meet deposit withdrawals immediately while also providing for the credit needs of our customers. We monitor our liquidity resources on an ongoing basis. State and Federal regulatory authorities also monitor our liquidity on a periodic basis. As of September 30, 2008, we believe our liquidity, as determined under guidelines established by regulatory authorities and internal policies, was satisfactory.

If needed, our banks have the ability on a short-term basis to borrow and purchase federal funds from other financial institutions. At September 30, 2008, the banks had available additional federal funds lines of credit totaling $23.0 million in place with five banks and $49.7 million of available funds on their lines of credit with the Federal Home Loan Bank of Atlanta.

At September 30, 2008, our capital ratios were adequate based on regulatory minimum capital requirements. The minimum capital requirements and the actual capital ratios on a consolidated and bank-only basis are as follows:

	Tier 1			Tier 1 Risk-			Total Risk-
	Leverage			Based			Based

Minimum required		4.00	%		4.00	%		8.00	%
Minimum required to be well capitalized		5.00	%		6.00	%		10.00	%
Actual ratios at September 30, 2008
Consolidated		9.27	%		12.75	%		13.98	%
Bank of Upson		9.47	%		12.48	%		13.69	%
The First National Bank of Polk County		12.16	%		17.92	%		19.18	%
Peachtree Bank		9.31	%		10.81	%		12.05	%
Bank of Chickamauga		8.49	%		15.82	%		17.08	%

Capital ratios may decline as asset growth continues, but are expected to continue to exceed minimum regulatory requirements. At September 30, 2008, the Banks were considered “well capitalized” by regulatory definitions.

Index

In response to the financial crisis affecting the banking system and financial markets, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.

On October 14, 2008, Secretary Paulson announced that the Department of the Treasury will purchase equity stakes in a wide variety of banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”), from the $700 billion authorized by the EESA, the Treasury will make $250 billion of capital available to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.

Treasury has announced that publicly traded institutions that wish to participate in the TARP Capital Purchase Program must apply before 5:00 p.m. (EST) on November 14, 2008, but that it intends to extend the deadline and promulgate different investment terms for institutions that are not publicly traded. Institutions that receive Treasury approval to participate in the TARP Capital Purchase Program have 30 days to satisfy all requirements for participation and to complete the issuance of the senior preferred shares to the Treasury.

Eligible financial institutions can generally apply to issue senior preferred shares to the U.S. Treasury in aggregate amounts between 1% to 3% of the institution’s risk-weighted assets. In the case of the Company, this would permit the Company to apply for an investment by the U.S. Treasury of between approximately $4.37 million and $13.12 million. We believe that our current capital levels will be adequate to sustain our operations and growth. However, given the uncertainties present in the economy, the Company has elected to apply for the maximum capital of $13.12 million.

Also, on October 14, 2008, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Paulson signed the systemic risk exception to the FDIC Act, enabling the FDIC to temporarily provide a 100% guarantee of the unsecured senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing transaction deposit accounts under a Temporary Liquidity Guarantee Program. Coverage under the Temporary Liquidity Guarantee Program is available for 30 days without charge and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing transaction deposits. All institutions are covered automatically under the Temporary Liquidity Guarantee Program until the opt out deadline of December 5, 2008. The Company is currently is evaluating whether to opt out of the Temporary Liquidity Guarantee Program.

Other than the items described above, we are not aware of any trends, demands, commitments, events or uncertainties that will result, or are reasonably likely to result, in our liquidity increasing or decreasing in any material way.

Off-Balance-Sheet Financing

Our financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of business. These off-balance-sheet financial instruments include commitments to extend credit and standby letters of credit. These financial instruments are included in the financial statements when funds are distributed or the instruments become payable. We use the same credit policies in making commitments as we do for on-balance sheet instruments. Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit, standby letters of credit and credit card commitments is represented by the contractual amount of those instruments. The table below contains a summary of our contractual obligations and commitments as of September 30, 2008.

Index

Commitments and Contractual Obligations

(Dollars in thousands)

	Less than
	one year		1-3 years		3-5 years		Thereafter		Total

Contractual obligations
Deposits having no stated maturity	$	269,278	$	-	$	-	$	-	$	269,278
Certificates of Deposit		182,344		44,223		19,152		-		245,719
Federal funds purchased		609		-		-		-		609
Short-term borrowed funds		14,973		-		-		-		14,973
Long-term borrowed funds		-		1,311		1,311		3,933		6,555
Deferred compensation		43		125		500		3,947		4,615
Construction commitments		-		-		-		-		-
Leases		137		156		168		330		791

Total contractual obligations	$	467,384	$	45,815	$	21,131	$	8,210	$	542,540

Commitments
Commitments to extend credit	$	29,986	$	-	$	-	$	-	$	29,986
Credit card commitments		8,974		-		-		-		8,974
Commercial standby letters of credit		882		-		-		-		882

Total commitments	$	39,842	$	-	$	-	$	-	$	39,842

Index

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

Pursuant to the revised disclosure requirements for smaller reporting companies effective February 4, 2008, no disclosure under this Item is required.

ITEM 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Our management, including the CEO and CFO, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based upon their controls evaluation, our CEO and CFO have concluded that our Disclosure Controls are effective at a reasonable assurance level.

There have been no changes in our internal controls over financial reporting during our third fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

The Company and its subsidiaries are subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of these pending claims and legal proceedings will not have a material adverse effect on the Company’s results of operations.

Item 1A.

Risk Factors

The Company may be unable to obtain a waiver or amendment to its outstanding line of credit, which could have a material adverse effect on the Company’s liquidity and ability to pay dividends.

Index

Actions by other financial institutions during a weakened economy could negatively impact our financial performance.

All financial institutions are subject to the same risks resulting from a weakening economy such as increased charge-offs and levels of past due loans and nonperforming assets. As financial institutions in our market area continue to dispose of problem assets, the already excess inventory of residential homes and lots will continue to negatively impact home values and increase the time it takes us or our borrowers to sell existing inventory. While the Company and all of its subsidiary banks are considered “well capitalized” according to regulatory definition, the perception of the banking industry has weakened in the market place. In this environment, there has been heightened attention on coverage amounts of FDIC Insurance. If our deposit customers should move a portion of their funds based on applicable deposit levels, our operating results would be affected.

The Emergency Economic Stabilization Act of 2008 (“EESA”) may not stabilize the financial services industry.

The EESA, which was signed into law on October 3, 2008, is intended to alleviate the financial crisis affecting the U.S. banking system. A number of programs are being developed and implemented under EESA. The EESA may not have the intended effect, however, and as a result, the condition of the financial services industry could decline instead of improve. The failure of the EESA to improve the condition of the U.S. banking system could significantly adversely affect our access to funding or capital, the trading price of our stock, and other elements of our business, financial condition, and results of operations.

Other Risks.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1. Business" under the heading "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2007, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item3.

Defaults upon Senior Securities

None.

Item 4.

Submission of Matters to a Vote of Security Holders

None.

Item 5.

Other Information

None.

Index

Item 6.

Exhibits

Exhibit No. 31.1

Chief Executive Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a)

Exhibit No. 31.2

Chief Financial Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a)

Exhibit No. 32.1

Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit No. 32.2

Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SouthCrest Financial Group, Inc.

(Registrant)


DATE: November 14, 2008	BY:	/s/ Larry T. Kugl
		Larry T. Kuglar.
		President and Chief Executive Officer

DATE: November 14, 2008	BY:	/s/ Douglas J. Hertha
		Douglas J. Hertha
		Senior Vice President, Chief Financial Officer